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Tuesday, 16 October, 2001, 11:40 GMT 12:40 UK
Brown and the downturn
Jenny Scott

Gordon Brown has undoubtedly been a prudent chancellor, but has also been a lucky one. In the four and a half years he has been at the Treasury, the economy has expanded by around 10%.

Tax receipts have been surprisingly high and spending on benefits has fallen in tandem with unemployment. That helped to turn a 28bn deficit in 1996/97 into an 18bn surplus in 2000/01.


Chances are the current spending is safe, but the probability of increases in subsequent years has gone down

Carl Emmerson, Institute for Fiscal Studies
But it is relatively easy to save money in times of plenty - on a personal level it is the equivalent of generous pay rises each year plus an unexpected annual bonus.

But how will Mr Brown cope in leaner times, the equivalent of a wage cut and a simultaneous increase in outgoings?

Economic downturn

That is the challenge facing the chancellor as he juggles an economic downturn, a subsequent fall in tax receipts and higher spending on defence.

Things will be tough for a time and borrowing will almost undoubtedly rise.

However, for the time being at least, the government's plans to pump billions of pounds into health and education are safe and talk of a public spending crunch and a return to early 1990s-style deficits is overdone.

The cost of war

It is impossible to say how expensive the current conflict will be.

The actual cost to the military is likely to be relatively small - less than the Gulf War which cost around 600m (once contributions from other countries had been taken into account) or the Bosnian conflict which cost around 1.2bn.

To put that in context, the government spends more than 300 billion a year and its own forecasting error in predicting borrowing one year ahead is around 10bn.

However, the indirect costs of the war against terrorism are likely to be much larger.

Slower growth in America and Britain in the wake of the World Trade Centre attacks will cut tax revenues and add to spending on items like unemployment and other benefits.

Slower growth

The Treasury's latest survey of independent forecasts predicts growth of just 2.1% this year, below the government's 2.25% prediction and significantly more pessimistic than the 2.6% being suggested this time last year.

That could leave a hole in the public sector balance sheet. The government's contingency reserve cannot be plundered to plug the gap as it is probably empty thanks to the unexpected bills from the foot and mouth epidemic.

And the economic downturn would make it a dangerous time raise taxes in order to make up the shortfall.

So why the conviction among many economists that the government's 50bn programme of health and education spending is safe?

Tricks up the treasury's sleeve

Firstly, the government is starting from a favourable fiscal position.

Mr Brown has consistently beaten his own expectations when it comes to the public finances and starts with a record surplus of more than 18bn in the financial year ending in March.

Secondly, his economic assumptions have been cautious. The Treasury has planned on growth of just 2.25% for the next three years, at the low end of expectations. Even the pessimistic forecasts this year are not much lower than this.

Thirdly, even if growth this year does disappoint, and the public finances deteriorate as a result, it is likely to be simply cyclical. In other words, the money is likely to be recouped when the economy turns up again.

If so, the first of Mr Brown's famous fiscal rules would still hold, namely that the current budget must balance over the whole cycle.

Tough decisions ahead

However, there are caveats. The conflict could mean permanently higher spending on defence, for example, which would disrupt the budget sums.

The extra strain on the public purse from the economic downturn and the war will also make it even harder for the government to continue spending at its current, strong rate beyond 2003.

"Chances are the current spending is safe, but the probability of increases in subsequent years has gone down," says Carl Emmerson at the Institute of Fiscal Studies.

Jonathan Loynes, chief UK economist at Capital Economics agrees.

"Whilst the twin prospects of a military campaign and sluggish economic growth in the next couple of years mean that borrowing will be rather higher than it would otherwise have been, the damage will be limited by the excellent starting point and the inherent caution already built into the Treasury's numbers," he says.

Loynes adds that some of the scare stories are overdone, egged on by the government.

"Maybe they're trying to manage expectations, which is a pretty familiar game for the government. Or maybe they'll increase taxes in the name of war and if it turns out to be unnecessary, they'll then give the money back in the form of tax cuts -- just ahead of the next election."

Will the UK economy feel the impact of the US slowdown?

Economic indicators

Analysis

UK rate decisions
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